Corporate Sector In Distress

Employment and capital spending will fall dramatically in 2009. Credit market problems are seeping into the real sector in ways that will prolong the recession. These are deep and worldwide problems.

We base these statements on a project we just completed, in which we talked to thousands of chief financial officers about the outlook for their own companies. Perhaps better than anyone, CFOs know the plans of their own firms over the next year. Aggregating CFO views about their own firms gives us a unique view of what the future holds for the overall economy.

This quarter, we asked CFOs to rate their optimism about the economy in the country in which their firm is based. CFO optimism in the US is 42 this quarter on a scale of 0 to 100. That is a whopping 20 points below the long-run average, and 10 below the previous historic low. CFO optimism is also bleak in Europe and Asia.

These numbers are ominous because, historically, CFO optimism has been an excellent predictor of future economic activity. Consistent with this, U.S. and European companies tell us that in 2009 they expect to reduce employment by 5%, and even Asia is expecting a decline in employment. In Europe and the US, even outsourced employment is expected to fall (by about 2%).

On top of that, companies around the globe plan to cut capital spending in 2009. In the US and Europe, capital spending will fall by more than 10%, and in Asia capex will drop 9 percent. Tech spending will fall by about 4 percent worldwide, and advertising and marketing will fall by 6 to 8 percent.

These weak numbers are devastating because plummeting capital spending at one company translates into weakness at another. And fired employees lead to an even weaker consumer sector. So it’s just not clear right now when this negatively reinforcing cycle will end. On top of that, our study detected that even some currently healthy firms are taking a “just in case” attitude and cutting headcount and spending as a precaution. Right now, the numbers in our study suggest that the economy will not begin to recover until Q4 2009 or even into 2010.

While weak demand and credit market turmoil are top of mind concerns for companies, CFOs also have other deep concerns. They are worried about employee morale in these tense economic times and the resulting negative effect this can have on productivity. About three-quarters of companies also say that they are worried about the financial health of their banks and other financial institutions with which they do business.

We also uncovered a worrisome trend that clarifies how a bad recession can continue to pull down the economy for quarters on end. When a company has difficulty borrowing, it may have to pass on attractive (i.e., positive NPV) projects simply because investment funding is not available. This can have a long-run impact and drag down profits (relative to what they otherwise would have been) for years into the future. The typical textbook would argue that a company should just borrow when needed to fund positive NPV projects. In contrast to this textbook view, our study indicates that about one-fourth of companies say that financial constraints in normal times have a moderate or large effect in limiting the ability of the firms to invest in attractive projects. Right now, it’s much worse. With bank lending tight or nonexistent for many companies, more than half of firms indicate that current financial constraints are a moderate or large drag on their ability to invest in attractive projects. This is killing corporate investment and suggests that the current recession will be prolonged.

We close by noting that the economic troubles are worldwide. Seventy-three percent of Chinese CFOs tell us that the government stimulus package in China will provide some cushion from the recession but not help to reverse the tide, and 19 percent say the stimulus will have little or no effect. In response, 75 percent of Chinese companies have instituted a head count freeze.

John Graham is the D. Richard Mead Jr. Family Professor of Finance at Duke University’s Fuqua School of Business,

Kate O’Sullivan is a Senior Writer at CFO Magazine

Each quarter the Duke University / CFO Magazine Global Business Outlook surveys thousands of chief financial officers around the world. The most recent survey concluded December 5th, and interviewed 1,275 CFOs in the U.S., Europe, and Asia. The survey has been conducted 51 consecutive quarters. See http://www.cfosurvey.org for more details.